Who's Minding the Store? Motivating and Monitoring Hired Managers at Small, Closely Held Commercial Banks

Small closely held corporations cannot rely on market forces or outside monitors to discipline hired managers. For such firms, managerial shareholdings may be a disproportionately important tool for controlling principal-agent problems. We study a random sample of 266 small, closely held U.S. commercial banks with a broad range of ownership and management arrangements. Our results suggest that hiring an outside manager can improve a bank's profitability, but these gains depend on aligning the hired managers with owners via managerial shareholdings. We find that over-utilizing this control mechanism results in entrenchment, while under-utilization is costly in terms of foregone profits